Matthew Benjamin: Good morning and welcome to Market Wake-Up Call. I’m Matt Benjamin, the new Editorial Director here at The Oxford Club. I’m filling in for Steve this morning because, well, he can’t interview himself, right? Steve’s here to talk about the Fed, the bond market and what it all means for investors. Welcome, Steve. Steve McDonald: Thank you, Matt. Thanks for doing this for me. Matthew Benjamin: Absolutely. So, Steve, according to a recent MarketWatch article, the corporate bond market is driving the bull market in stocks right now. How does that work? Can you explain that to us? Steve McDonald: I mean, you think we're making money in stocks... I’ve made so much money in bonds this year it’s ridiculous. And here’s how it works. Public pension funds have to earn 7.5% a year, as a minimum, just to meet their obligations. And the only place they're going to get that kind of yield is the corporate bond market, and they're buying junk bonds and investment grade – mostly junk. Now, the companies selling these bonds to the pension funds are taking the cash from the sale of the bonds and using it to buy back their own stock. And it’s really an amazing number. The amount of stock buybacks, since 2009, is $3.2 trillion. The amount of bond sales is $3.3 trillion. It’s almost a 1-to-1 correlation. And what’s happening is the buybacks are a major force in driving this bull market. The typical buyers – you know, households, hedge funds, mutual funds – they have a net sale of stocks since 2 – Matthew Benjamin: Now hold on, Steve, let me take a step back for a moment if you will. Why do these corporations want to buy back their own stock? Can you explain that to us? Steve McDonald: Yeah, it makes the earnings per share look bigger because there are fewer shares that divide into the earnings. It makes the stock price go up. In fact, I did a segment a few months back where I talked about all the CEOs – 10 of the S&P 500 CEOs – who have been selling their stock and then buying it back because the stock price has been going up. So it’s a win-win for the corporations and for the stockholders. Matthew Benjamin: Sure, it makes total sense now. Another question related to that, Steve. The Federal Reserve is about to begin unwinding its massive balance sheet. I think it’s $4.5 trillion when you count it all up. How will this affect the corporate bond market in relation to what we were just talking about? Steve McDonald: Well, that unwinding is – the way I understand it is they purchased all these Treasury bonds, notes and bills. They're not going to sell them into the market; they're going to allow those to mature. In the first month that they're going to do it, it’s going to be $10 billion worth of bonds. But in a year, it’s going to increase to $50 billion worth of bonds a month. Now, how is it going to affect the corporate bond market? That’s not a really direct relationship. The only direct relationship we have is to the stock market and to Treasurys. Thanks to the buying pressure that the Fed had been putting on Treasurys – when they were buying $4.5 trillion worth during quantitative easing – as they stop buying, the prices are going to drop on Treasurys and the yields are going to go up. So we should see an increase in Treasury yields, maybe in savings, maybe in CDs – that’s not as guaranteed. But the other problem is that as yields go up on government bonds and Treasurys, stocks become less attractive because people were pushed into the stock market since 2009 because they couldn't make any money at all on guaranteed investments. The 30-year bond right now... If you give your money to the government for 30 years, it will pay you 2.8%. Don't do me any favors! Matthew Benjamin: Right. Steve McDonald: The 10-year is 2.3%, for God’s sake, and you have a 10-year commitment. That’s $23 a year for a $1,000 investment. So as those yields on the 10- and the 30-year go up back toward normal – which is about 4.5% for the 10-year and about 7% for the 30-year – stocks become less attractive. Why take risks in the stock market to earn 7% if you can get to that or close to that from a guaranteed government bond? I mean those are the two guaranteed relationships. The corporate bond market, it’s hard to say. Corporate bonds are tied more directly to the buying pressure in the corporate market of course, which is through the roof, and fundamentals. So unless we see some major shift in the economy, I don't expect any sell-off in corporates. Matthew Benjamin: Wow, that’s interesting. Thanks for joining us today, Steve. Steve McDonald: Oh thank you, Matt. Thanks for filling in for me. Matthew Benjamin: Great, anytime. And that’s all for this week’s Market Wake-Up Call. We’ll see you again next week. [End of Audio]